Aware (AWRE) is a small software company with two primary lines of business: biometrics and imaging software, and Digital Subscriber Line (DSL) service assurance software and services. Software companies in Magic Formula� Investing (MFI) have always piqued my interest, and micro-caps are always entertaining to investigate, so lets dig into this one!

Over 75% of Aware's revenue comes from providing a wide array of software offerings to customers to create biometrics applications. Biometrics is the use of body markers - fingerprints, facial pictures, eye scans, etc. - for identification purposes. Aware provides software components, "building blocks", for customers to build full biometrics applications from. There are 3 channels of distribution: systems integrators (those who develop custom end-to-end biometrics solutions for clients), OEMs (those who provide "off-the-shelf" biometrics solutions), and direct sales to end users. Most of Aware's sales in the biometrics business are to local, state, and federal governments, mainly law enforcement agencies.

13% of revenues come from Aware's DSL service assurance offerings. DSL is a common technology used by many phone companies to deliver broadband Internet over existing telephone landlines. Aware's "Dr. DSL" technology is a suite of software that allows service providers to monitor, manage, and improve their DSL networks.

In biometrics and DSL, Aware uses a typical software sales model. New licenses and renewals make up the bulk of revenues, about 60%. Maintenance/Support contracts are about 18% of sales. Services consist of consulting, implementation, and other transactional activities, amounting to about 12% of sales. This past quarter, Aware booked a substantial $1.1 million on a biometrics equipment deal with a government customer, but it is unclear what the potential is for this business going forward.

Biometrics and DSL assurance are the two ongoing businesses, but Aware has a few other auxiliary sources of revenue. The company AWRE)+Agrees+to+Sell+DSL+and+Home+Networking+Lines+to+Latiniq/5029432.html" target="_blank">divested its DSL silicon intellectual property ("IP") in 2009, but still earns royalties from customers that use it in current products. Royalties represented 11% of sales last year but has fallen to about 5% this year and will soon dry up completely.

The company also has an ongoing program to monetize its patent portfolio, and has made some big scores in the past year. The firm sold wireless patents to Intel (INTC) last year for a cool $75 million, and then $16 million worth of DSL patents to TQ Delta a few months later. These proceeds were used to fund two big special dividends, a $1.15/share ($25 million) payout last May, and then another $1.80/share, $40 million payout in December. All told, Aware shareholders earned nearly a 60% yield in dividends last year! And the company still has an enviable balance sheet - $76 million in cash and no debt. Considering Aware's market cap is just $115 million, its cash alone makes up 2/3rds of its value.

Unfortunately, the likelihood of more patent sales is low. After the DSL patent deal, management commented that most of the remaining portfolio were needed to protect ongoing businesses.

I like Aware's business. Biometrics is clearly a growth market, with not only ever-increasing applications in law enforcement and national security, but also in consumer markets for things like cell-phone locking. DSL is an older technology but not one that will be going away any time soon, given existing phone line infrastructure. License growth is always lumpy, but over the past 3 years has grown at around a 10% annual clip. Maintenance contracts, a more "smooth" revenue line item, have been growing at 25-30% annually since 2010. Services are unpredictable but have worked out to about $3 million a year. The DSL hardware deal is a real wild-card, but I've provisioned about $2.5 million for that this year. Finally, I see patent royalties adding up to a little over $1 million this year and bleeding off by the end of next year.

Given all that, and taking the big cash balance into account, I see Aware worth about $5.50/share. That's quite a modest gain from current prices around $5. Those interested should also note that this is a rather difficult company to project for - management does not give any tangible guidance and for that matter doesn't even conduct conference calls! Still, I feel there is a good opportunity for meaningful upside from my expectations, and Aware is a stock that more aggressive MFI investors might want to have a look at.

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